VALLOUREC S.A. ORD (VLOUF) news: Vallourec: A Niche Play To Profit From …

General information

Vallourec (OTCPK:VLOUF) (OTCPK:VLOWY) is a French mid-cap and the world’s leader in the production of non-welded steel tubes and specialized tube products for industrial applications. The company’s main products are hot-rolled pipes and pipes for oil and gas use; welded titanium pipes for use in secondary cooling circuits for conventional and nuclear electrical plants; and other types of steel welded pipes, hot-finished, machined, or cold-rolled unwelded pipes, weld connections, etc.

The stock trades with high liquidity on European exchanges, especially on its home exchange in Paris, while in the USA, investors can buy on the OTC segment either the ordinary shares, represented by the ticker symbol VLOUF, or its ADRs (ticker VLOWY), representing each one-fifth of an ordinary share.

The stock hasn’t done well since the end of the steel boom: it trades only 20% above its March 2009 level and close to its book value.

As the company has a solid balance sheet with little debt and managed to achieve positive EPS even over the past, relatively bad years, it might pay off to take a closer look at its business, especially since consensus estimates show earnings growing at high double-digit rates and the forecast is supported by strong tailwinds for the market niche Vallourec serves.

Transformation

Over the past few years, the company has significantly enlarged its operations in the oil and gas sector, with rapidly growing sales in North and South America:

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Vallourec clearly benefited from the growing demand for deepwater drilling-related equipment:

But on the other hand, it suffered from reduced investments in conventional power generation:

This evolution in the company’s sales mix forced the company, who was losing a lot of its traditional power generation-related business in Europe, to allocate huge amounts of capital to new mills in Brazil, the USA, the Middle East and China, which put under strain Vallourec’s results in the past few years. However, the years of transformation have now ended, as the company has recently stated, and Vallourec stands ready to reap its awards.

Investment thesis

The investment thesis for Vallourec is mainly based on the foreseeable continuing growth of capital expenditures for unconventional oil and gas plays and deepwater projects. As these types of wells need far more seamless pipes and connections than traditional wells, and new sources of oil and gas are found in more difficult-to-drill locations, Vallourec will likely see growing demand in the market niche it serves.

In addition to its pipes and connections, Vallourec provides highly specialized services to its customers (Petrobras (PBR), Shell (RDS.A), Total (TOT), Chesapeake Energy (CHK), Devon Energy (DVN), among others). The following slides from the company’s most recent Investor Day presentation illustrate its partnership with the Brazilian oil giant, Petrobras:

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Over time, Vallourec literally followed its customers’ footsteps:

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Of course, a close partnership like this provides a strong moat against competition. As Vallourec’s products represent only 5%-10% of the total cost of an oil or gas well, and customers surely appreciate the highly personalized service and strong safety record coming with the 100+ years of experience the French company boasts, very few clients will even start thinking about switching to a competitor.

Risks

However, there are some serious risks to take into account:

– Currency devaluation, especially in Brazil. Vallourec makes 22% of its sales in South America.

– Political / environmental issues related to deepwater drilling could reduce investments in this sector. Vallourec’s products are used in 75% of the largest deepwater projects worldwide.

– Continued pressure on gas prices could reduce capital expenditures for gas wells. (On the other hand, rising gas prices would lead to increasing revenues for Vallourec.)

– Vallourec’s still-large workforce in Europe causes high costs and is unlikely to be reduced quickly. Strongly-protected employees in Germany and France still represent 40% of total employees, are among the highest-paid employees worldwide and work on average 25% less hours than employees in other countries, while the company’s European markets are shrinking. (Sales halved from 2008 to 2013.) In the meanwhile, Vallourec must employ and train new workers in Brazil and in the USA. I estimate that the far too large European workforce will put under strain Vallourec’s bottom line for the next decade or so. (For further analysis of the company’s workforce, age, payrolls, etc., take a look at the 2012 annual report, pages 64-69.)

Valuation

Consensus estimates forecast EPS to grow to €3.52 by 2016 from €2.10 in 2013, representing a CAGR of 19%. Average EPS for the next 3 years is forecast to reach €3.12.

Average EPS for the past 3 years was €2.43, hence, the company presently trades at about 15.5 times this figure and almost precisely at book value (which stands at €39.90), or at 12.2 times the forecast next 3 years’ average EPS.

Looking at private transactions, in 2007, one of Vallourec’s major competitors, Tenaris, acquired Hydril, a North American manufacturer of premium connections for 15 times EBIT. This metric would put Vallourec’s sales price at about €8 billion, while its current enterprise value stands at €6.5 billion.

Considering the rather low reliability of EPS forecasts in this sector, and the Tenaris-Hydril transaction, in my opinion, Vallourec at this point is certainly no screaming bargain, but might still be undervalued by 10%-20%.

Resources for further analysis

Vallourec IR website

Annual report 2012

Investor presentation

Consensus estimates

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More…)